High-growth tech stocks seem particularly volatile these days, driven high and low by rising and receding fears related to interest-rate rises and COVID waves. It’s enough to make the average investor forswear the tech sector.
But please don’t fall into this trap. High-growth tech-stock volatility is nothing new. I would know. For the past 25 years, I’ve covered the Internet sector, which has created some amazing stock market returns – Netflix
up 45,000% since its IPO and Amazon.com
up 166,000% since its IPO – as well as some downright duds – Blue Apron
both down 90% since their IPOs. And along the way I’ve learned some valuable lessons that you can use when making your own stock picks.
At a high level, when we invest in high-growth tech stocks, we’re trying to manage two types of risk: fundamentals risks and valuation risk. By fundamentals risk, I mean the risk of revenue and profit shortfalls – not just missing Wall Street estimates on any given quarter, but of revenue growth dramatically slowing and margins collapsing, perhaps due to market saturation or competitive pressures or management mistakes or some other factor.
Valuation risk is the risk of a material de-rating or decline in a company’s valuation multiple, either due to a fundamentals correction or a broad market de-risking, such as when there’s a significant change in interest rate expectations.
My best advice for mitigating these two risks is to hunt for DHQs, or Dislocated High-Quality stocks. By dislocated, I mean stocks that have declined 20%, 30% or more from recent highs. Now there’s a fair amount of judgment required here. A 20%-30% correction off of a rapid 100% appreciation spike isn’t that dislocated.
Another source of ideas is stocks that are trading at a discount to their growth rates – stocks whose forward-looking P/E multiple is less than its forecasted growth rate for earnings per share.
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One thing I have found through my 25 years of looking at tech stocks is that even the highest-quality stocks – Amazon, Apple
Google parent Alphabet
and others — get dislocated from time to time. It happens a lot more than most investors …….